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Brexit confusion

After a strong September in the EUA market has come an even stronger October, with Dec-17 closing prices trading in a 6.9–7.8 €/t range, and at least one intraday session seeing prices pass 8 €/t. Over October the closing price has averaged around 7.30 €/t, up by 7% m/m and 28% y/y.

Some of the month’s price support and volatility was driven by policy development. The biggest factor was the agreement at a trilogue meeting to include the ‘Brexit clause’ in an EU bill on aviation. The bill will now need final confirmation from both the European Parliament and the European Council before it can be published in the Official Journal of the EU and become law.

The market started to get some clarity on how this clause could be made operational. A European Commission (EC) ‘non-paper’ (effectively a discussion paper that falls short of being a draft legislative proposal) has been circulating and outlines proposed changes to the registry regulation that would be needed to support the Brexit clause’s practical implementation.

Importantly, the paper includes the EC’s interpretation of the phrase ‘lapsing obligations’. The EC spells out clearly that it believes that in the absence of any agreement on the future relationship between the EU and the UK, ETS law will cease to apply to the UK as of 30 March 2019—the two-year Article-50 Brexit deadline. As such, the non-paper suggests UK installations would not have an obligation to surrender, by 30 April 2019, allowances corresponding to the verified emissions made during the calendar year 2018. In essence, the EC intends that UK installations should be treated as having lapsing obligations from 1 January 2018, which would potentially void all EUAs created by the UK in 2018.

Such an interpretation misses the intention of the UK ‘Great Repeal Bill’ which, assuming it is passed, will keep ETS obligations on UK installations—copying over these obligations into UK law. As such, UK installations will retain ETS obligations until such a time that a UK act of parliament removes them. The proposed EC interpretation suggests that there will be disruption to EUA trade at the start of 2018, followed by a period when there will be two tiers of EUAs—those UK EUAs which exist solely in the UK registry, and all other EUAs. The passage of the Brexit clause will make it likely that trade in and out of the UK registry could be stopped entirely during 2018, thus massively increasing the potential market disruption expected from Brexit.

In other European developments, the new Dutch coalition government this month announced two ETS-impacting policy initiatives—the closure of all Dutch coal plants by 2030 and the introduction of a carbon tax on generation fuels from 2020 (starting at 18 €/t, inclusive of the EUA price). Such a tax should decrease carbon emissions in the Dutch power sector. If it pushes Dutch coal plants to peak loads only, Dutch power sector annual emissions would drop by 6.5 Mtpa. The Dutch decision raises the question of which country will next introduce additional carbon charges, with all eyes now focused on talks to form a new coalition government in Germany. The proliferation of individual country carbon taxes offers downside for EUA prices.

We continue to expect little in the way of a price correction downwards, with Q4 17 prices likely to be trading in the 6.5–7.75 €/t range. We forecast that prices in Q4 17 will average 7.25 €/t, a 0.5 €/t increase on last month’s forecast. We also forecast that prices will rise to average 8.8 €/t in 2018, up by 1.0 €/t from last month’s view, given that the disruption from the Brexit clause will have a bigger supply-side effect than a demand-side effect.